SMEs Warm to GAAP Alternatives

Alternative accounting methods are becoming more attractive to small and medium-size companies, especially with formal standards on tap.
Kathy HoffelderJune 26, 2012

With GAAP still too complex and onerous for many small, private companies, some other financial-reporting alternatives are starting to look more appealing.

“GAAP is not the end-all, be-all. There are other alternatives out there,” said Salvatore Collemi, quality control senior manager at accounting firm Rothstein, Kass & Co., at a New York State Society of CPAs conference last week.

The prospect of having formal financial-reporting standards in place for privately owned small and medium-size entities (SMEs) is helping that sentiment along. Some senior executives at such firms are taking a closer look at the American Institute of Certified Public Accountants’s (AICPA) formal framework for SME reporting. The framework sets standards for an accounting approach called “other comprehensive basis of accounting,” or OCBOA.

Private companies typically base financial statements on GAAP, when they use it, to satisfy loan covenants with lenders, but often use the simpler OCBOA statements to include such items as nontaxable revenue that are not covered under GAAP. Until now, there was never a formal set of separate standards for the OCBOA. The AICPA expects the framework to be ready by the first half of 2013.

The AICPA’s formal approach to SME reporting comes directly after the Financial Accounting Foundation, parent of the Financial Accounting Standards Board, announced its own answer last month to private-company accounting woes: a private-company council to modify U.S. GAAP.

Formalizing private-company SME accounting is welcome news for most smaller companies. The OCBOA has fewer reporting steps than GAAP, does not require a cash-flow statement, and is usually cheaper to prepare.

GAAP theoretically should work for small, private companies, but in reality it often doesn’t, says Kim Lamplough, partner in the assurance division at accounting advisory firm Marcum LLP. SMEs, for example, often invest in the buildings where they’re housed, which can create GAAP reporting problems, she says.

“All of a sudden, the small business owner finds himself involved in variable-interest-entity accounting conversations, where he has to explain to the [building’s] banker that in order to comply with loan covenants he has to provide GAAP statements,” says Lamplough. “They now have to consolidate the operations of the entity that owns the building into the [company’s] financial statements.”

The formal approach to SME financial reporting should also give companies an extra layer of credibility with their lenders, since the standards will be much more uniform, according to Lamplough.

The new affinity for the OCBOA coincides with a revamp of the framework itself. The OCBOA will eventually undergo a name change to “Special Purpose Framework,” which should appeal to a wider audience, says Collemi. It will also include an additional basis of accounting that will coexist with the other four ways the OCBOA statements can be prepared currently: on a cash or modified-cash basis, an accrual income-tax basis, a regulatory basis of accounting, or a set of criteria that can be applied to all material items in the financial statements, he says.

Although the OCBOA is still generally more popular than other international reporting standards for SMEs, some U.S. companies are already warming to the way non-U.S. companies are reporting. U.S.-based SMEs are becoming more accepting of the International Accounting Standards Board’s international financial reporting standards (IFRS) for SMEs, sometimes called “IFRS Light.” The attraction comes after years of participants’ turning up their collective noses at the 230-page standard, released in July 2009.

The increasing appeal of IFRS Light comes as more companies look to expand overseas or attract international investors, while GAAP remains appropriate for companies that are highly leveraged or are planning to go public.

“There are now more jurisdictions in the world that recognize IFRS Light than U.S. GAAP,” said Collemi. More than 70 countries have adopted or announced plans to adopt IFRS for SMEs, according to a report from the IASB earlier this year.

But a full leap to IFRS Light could still be light-years away. “An entity that wants to report that way has to get a blessing from the infrastructure in the United States — its bankers, lawyers, vendors, suppliers: all the people it does business with,” Collemi tells CFO.

“That’s the challenge, and it takes time for that infrastructure to get the knowledge so that when they look at those financial statements, they will know what they are looking at,” he says. “It’s still difficult for entities to choose this right now. It’s the fear of the unknown.”

The Securities and Exchange Commission has not helped to speed things along, either. The SEC had hoped to decide late last year whether to require U.S. public companies to adopt IFRS. If that does not happen, then it’s less likely that IFRS Light will be adopted anytime soon.

Indeed, U.S. GAAP is gradually becoming less common with suppliers and customers overseas as alternate versions of other accounting standards proliferate. “In an international environment, companies that are not publicly held have more choice [of reporting standards]. In the United States, we are moving to that model,” says Lamplough.

Today the IASB started a public-comment period on IFRS for SMEs that ends on November 30. The IFRS Foundation SME Implementation Group will hold its first physical meeting on the topic in the first quarter of 2013. A final revision to the standard is expected in the second half of next year or first half of 2014.

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